One of the rare few oscillators that factor in the volume of the stock is the Elder’s Force Index. It is used for trend identification, corrections, and for identifying potential reversals.
What is Elder’s Force Index?
This indicator was developed by Dr. Alexander Elder in 1993. It measures the force or power of bulls behind price rallies and the force or power of bears behind price declines. Unlike regular oscillators, this oscillator fluctuates around the zero line.
Elder’s force index takes 3 things into account – the extent of the price change, the direction of price change, and the trading volume. All three are combined by the EFI to create the oscillator.
EFI is calculated as the difference between the current and the previous closing price multiplied by current trading volume. The default period is taken as 13 period and the 13-period Force Index is computed by taking 13 period EMA of above calculated Force Index.
Whenever there are large price movements on large volume, there are usually spikes on the EFI indicator. The figure below shows the Elder’s Force Index.
Elder’s Force Index and Trend
Elder’s force index can pinpoint whether strong shifts are happening in buying and selling momentum. Typically, the farther the Force Index line away from the zero line, stronger is the trend.
- Uptrend: When the Elder’s Force index remains above the zero line, it indicates an uptrend. When EFI goes above the zero line forcefully, it indicates a strong buying pressure.
- Downtrend: When the Elder’s Force index remains below the zero line, it indicates a downtrend. When EFI goes below the zero line forcefully, it indicates a strong selling pressure.
Elder’s Force Index and Corrections
Elder’s force index can be used to identify corrections in a trending market.
- Bullish Market Corrections: When the EFI goes below zero during an uptrend, it typically rallies back above zero soon. Traders can choose long positions when EFI is below zero to make profitable trades.
- Bearish Market Corrections: When the EFI rallies above zero during a downtrend, it typically drops back below zero soon. Traders can choose short positions when EFI is above zero to make profitable trades.
Elder’s Force Index and Divergences
Elder’s force index divergences can be used to identify whether the trend is weakening. Divergence is said to happen when the EFI indicator and price do not move in the same direction. This usually means that either volume or the extent of price moves has slowed.
- Bullish Divergence: When the price makes a lower low (or similar low) while the Elder’s Force Index makes a higher low, it is called as a bullish divergence. This indicates that the selling pressure is decreasing and the price may move higher.
- Bearish Divergence: When the price makes a higher high while the Elder’s Force Index makes a lower high, it is called as a bearish divergence. This indicates that the buying pressure is decreasing and the price may move lower.
How Traders Use Elder’s Force Index
Following are the ways in which traders use Elder’s force index for making better trades
Bullish Signals
- When the stock is in an uptrend and the force index turns negative, traders enter or add to long positions.
- When there is a bullish divergence between EFI and price, traders go long.
- When elder’s force index stays above zero, the uptrend is expected to continue and traders go long.
Bearish Signals
- When the stock is in a downtrend and the force index turns positive, traders enter or add to short positions.
- When there is a bearish divergence between EFI and price, traders go short.
- When elder’s force index stays below zero, the downtrend is expected to continue and traders go short.
The figure below shows how Elder’s Force Index can be used to identify bullishness and bearishness.
Happy Trading!
Tara